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Carter Corporation has some money to invest, and its treasurer is choosing between City of Chicago municipal bonds and U.S. Treasury bonds. Both have the same maturity, and they are equally risky and liquid. If Treasury bonds yield 6%, and Carter's marginal income tax rate is 40%, what yield on the Chicago municipal bonds would make Carter's treasurer indifferent between the two

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Answer:

If Chicago municipal bonds yield  is 10% then Carter's treasurer make indifferent between the two.

Explanation:

Because Treasury Bond is exempt from tax income and both have same maturity, and they are equally risky and liquid; we then have the equation as below

Treasury bonds yield = Chicago municipal bonds yield after tax

⇔ 6% = Chicago municipal bonds yield * (1 - tax rate 40%)

⇔ 6% = Chicago municipal bonds yield * 0.6

⇒ Chicago municipal bonds yield = 6%/  0.6 = 10%